Should Nonprofit Directors Worry About Personal Liability?

A nonprofit's directors are usually -- but not always -- protected from personal liability for lawsuits against the nonprofit.

Most people know that incorporation protects business owners from personal liability. Anyone who wants to sue over a business-related debt or injury must go after the corporate entity, not the personal assets (cars, homes, or bank accounts) of its owners. It's an important protection, given the range of possible lawsuits against businesses -- perhaps by a disgruntled employee claiming wrongful termination, an unhappy vendor claiming breach of a contract, or a visitor who was injured on the front walk.

But do nonprofit corporations enjoy similar protections for their staff, board members, and officers? Fear of personal liability stops many people from joining boards of directors at all -- although the number who have actually been sued is quite small. The news is good for nonprofits, though with certain exceptions. Once your organization is incorporated, its directors or trustees, officers, employees, and members usually won't be on the hook personally for the nonprofit's debts or liabilities. That includes unpaid organizational debts and unsatisfied court judgments against the nonprofit.

How Protection From Personal Liability Works

Consider, for example, a nonprofit symphony that's sued by an audience member who, during intermission, falls because of a poorly maintained staircase railing.

If the court finds in favor of the audience member, it could issue a judgment against the nonprofit for a large amount -- perhaps greater than the nonprofit's insurance coverage. The amount of the judgment becomes a debt of the nonprofit corporation. But thanks to its corporate status, the nonprofit's directors, officers, and members are not personally responsible for paying that debt.

By contrast, if an unincorporated association of musicians owned the premises, the principals of the unincorporated group could be required to pay the judgment amount out of their own pockets -- thus putting their personal assets at risk. (Some states' laws, however, offer protection to people affiliated with unincorporated associations.)

Exceptions to the Limited Liability Rule

In a few situations, people involved with a nonprofit corporation can be held personally liable for its debts. A director or officer of a nonprofit corporation can be held personally liable if he or she:

personally and directly injures someone

personally guarantees a bank loan or a business debt on which the corporation defaults

fails to ensure that the nonprofit deposits taxes (such as payroll and property taxes) or files necessary tax returns

does something intentionally fraudulent, illegal, or clearly wrong-headed that causes harm, or

co-mingles nonprofit and personal funds.

To cover some -- but not all -- of these exceptions, reasonably priced insurance is available to protect the nonprofit and its volunteer directors and officers. Also, the federal Volunteer Protection Act (VPA) and a number of states' laws (in California, Massachusetts, and New York, for example) also offer qualified immunity or similar protection from liability for volunteers who essentially acted in good faith and in the best interests of the organization.

A word of caution on unpaid taxes

A nonprofit's unpaid taxes can raise the biggest risk in terms of board members' liability. A failing nonprofit may find itself unable to pay taxes, and then close its doors. After that, the IRS may turn to the board of directors for payment, and the board members may discover too late that their insurance doesn't cover unpaid taxes.